As a wealth manager, one of the key principles to understand is that while we can’t control everything, like market performance, we can control strategic decisions that impact a client’s financial future. One such controllable factor is the timing of retirement. Your final employment date is normally set in your employment contract. One should be aware that your retirement date from your employer (stopping to work) might be different from the retirement date from your employer’s retirement fund.
When it comes to retiring and transitioning into a living annuity, timing isn’t just a detail, it can be a critical strategy.
Understanding the relationship between retirement date and living annuity effective date
When you retire, there are three important dates to consider:
1. Retirement date: Your official last day of work.
2. Retirement date of the fund: Date when you convert your retirement fund into a living annuity
3. Effective date of the living annuity: The date your living annuity begins to pay an income.
The month in which your living annuity starts becomes your anniversary month. This is not just a ceremonial milestone, it determines when you’re allowed to:
- adjust your income withdrawal (payment) rate
- change the frequency of your income payments (monthly, quarterly, semi-annually or annually)
While this may sound straightforward, the real complexity lies on the tax side, especially when transitioning from monthly to annual income frequency payments.
How tax implications can affect your retirement income
When the South African Revenue Service (SARS) calculates your annual tax liability, they assess the total income received from your living annuity within a tax year. In South Africa, a tax year runs from beginning March to end February.
Example: The tax impact of a living annuity anniversary not aligned to the start of the tax year
Let’s assume:
Your retirement date is April and your living annuity starts in June (making June your living annuity anniversary month). Your income for May was covered through additional savings you held.
You receive R30 000 per month before tax.
You decide to receive an annual income payment (once-off) from your living annuity in June, as opposed to monthly income payments as this aligns to your specific needs for the next 12 months.
Here’s what happens:
- From March to May, you received monthly payments totalling R90 000.
- In June, you opt for an annual payment from your living annuity and receive a lump sum of R360 000 to cover the next 12 months.
- SARS views this as a significant income spike within the tax year, pushing you into a higher tax bracket.
- As a result, your marginal tax rate jumps from 26% to 31%, increasing your overall tax liability unnecessarily. Instead of earning R30 000 per month for the tax year totalling R360 000, you now earned R360 000 plus the R90 000, pushing up your marginal tax rate.
- This tax rate could even be pushed higher if you earned income from other sources and not just your living annuity, like rental income or interest from other investments.
The solution: Aligning your anniversary with SARS’ tax year-end
On average, it takes around 30 days to make payment from the employer fund. By planning your retirement from the fund for January, your living annuity will likely start in March, aligning your anniversary month with the start of the new tax year. The benefits include:
More control over tax: Changes to your income from your living annuity won’t trigger tax spikes because SARS will assess these changes across the new tax year.
Flexibility to adjust withdrawals and frequency: You can make strategic decisions annually without overlapping into different tax cycles.
Smoother financial planning: Your income adjustments align with both your personal budget and SARS’ tax calculations.
The process: From retirement date to living annuity effective date
To align your living annuity’s effective date with the start of the tax year, follow these steps:
- Consult your human resources department: Negotiate your final working day to fall in December or January.
- Coordinate with the retirement fund administrators: Confirm the timeframe needed to process your retirement. This process typically takes 30 days from your last working day.
- Set the effective date of the living annuity strategically: Aim for the living annuity to start in March, aligning your anniversary with the new tax year.
- Ensure you have other investments in place to provide an income during the transition period from retirement to your living annuity effective date.
- Review annually: Each year during your anniversary month, reassess your income needs and tax position with your wealth manager.
Key takeaways
- You can’t control market performance, but you can plan your transition from your fund retirement date to your living annuity effective date.
- Aligning your living annuity’s anniversary month with the start of the tax year, helps you manage income payments more effectively and allows greater flexibility when choosing your annuity frequency.
- Consult your HR department and retirement fund administrators to best align your fund retirement date with your financial goals.
Strategic retirement planning isn’t just about how much you save, it’s also about when you choose to retire. Make the timing work for you.